Fresh tensions clouded the summit of European leaders in Brussels this week, as countries from the southern bloc – France, Italy, Spain, Portugal and Greece – increasingly questioned the German-backed economic policies they believe have doomed them to deepening recession and rising unemployment.

The stakes are high, given the political stalemate in Italy and Germany’s reluctance to discuss any big change to austerity programs before its September elections.

With an eye to German voters, German Chancellor
Angela Merkel
is insisting that debt-laden countries must embrace savage budget and salary cuts to restore their finances and rebuild their competitiveness.

But France is pushing back. On Tuesday French President
Francois Hollande
declared France would fail to meet its target of reducing its budget deficit to 3 per cent of GDP this year. Instead, he said the deficit would “probably stand at 3.7 per cent in 2013, even though we will try to make it lower".

Banker criticises slippage

The head of Germany’s powerful Bundesbank,
Jens Weidmann
, was quick to criticise the slippage, noting that reform efforts in France appeared “to have floundered" as the country was seeking additional time to meet its deficit targets.

“Particularly in the big countries, it is important that there is a signal that the new [stability and growth pact] commitments are taken seriously," the Bundesbank boss warned.

Signs that rules were being ignored “would be a bad signal for the whole currency union".

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Hollande, however, was unrepentant. He believes that efforts to shrink budget deficits should not be allowed to curb growth, pushing the economy into recession.

The recent Italian elections have bolstered his case: in Italy, as in Spain and France, voters are increasingly sceptical of the benefits of Merkel’s austerity cure.

France sees strong Euro as an economic drag

But austerity isn’t the only target of Hollande’s attack. He is also frustrated by Berlin’s refusal to discuss policies that would limit the rise of the euro. In a speech to the European Parliament last month, Hollande argued the strong euro was hampering the region’s efforts to boost growth and productivity and urged Europe to join in the global currency wars.

The region, he said, “should have a foreign exchange policy, otherwise it has an exchange rate imposed on it that does not correspond to the real state of the economy".

Senior French politicians believe that the strong euro is acting as a huge drag on the region’s economic activity. The currency has risen sharply since mid-last year, pushing as high as $US1.36 before edging back to around $1.30.

Many economists believe that this is still too high and that a more appropriate level would be $1.15 to $1.20 to the euro.

The issue has become extremely sensitive for Paris, which is desperately trying to kindle growth by boosting the competitiveness of French exporters.

Many senior French politicians believe that the euro is the victim of unfair competition, as central banks in the US, Japan and Britain have printed huge amounts of money, driving their currencies lower.

In contrast, the more conservative European Central Bank believes in allowing market forces to operate. At the bank’s headquarters in Frankfurt, senior ECB officials point out that the euro is trading within its historic range and that consumers and some corporations benefit from a stronger currency because it causes the price of imported goods to fall.

In addition, oil and gas prices – which are denominated in US dollars – drop when the euro strengthens.

But there are also clearly some downsides.

The strong euro has meant many of the region’s producers have lost competitiveness against rivals from the US or Japan (the euro has climbed by 12 per cent against the yen in the past three months) and are either watching as their market share shrinks or are reducing their prices and suffering a squeeze on margins. Analysts have pointed out that the last time the euro zone experienced strong growth was back in 2000, when the euro was worth less than 90¢. Every time it rises above $1.20, growth has collapsed.

One study has estimated that a 10 per cent fall in the euro against the currencies of the region’s trading partners boosts growth by 0.7 per cent after one year and by 1.3 per cent over two years.

But a rise in the euro depresses growth by the same amount.

There are now fears the strong euro is cancelling the benefits from the painful reforms that southern euro zone economies have undertaken to boost competitiveness, and that this will make it near- impossible for them to escape from recession.

Earlier this month, outspoken French Industry Minister
Arnaud Montebourg
launched a stinging attack on the ECB, saying it should do more to push the value of the euro lower.

“Our global competitors use foreign exchange," he said in an interview on French radio.

“We are asking [ECB boss] Mario Draghi to give us the weapons to fight unfair globalisation so as not to be the naive people of the global village."

He also called on the bank to do more to boost growth and curb rising unemployment.

“The European Central Bank is remarkably inactive in a period when we need activism," he said, pointing out that other central banks were happily buying government debt.

French criticisms are fuelling the political tensions within the euro zone and highlighting the fundamental split between the northern group (which includes Germany, Austria, the Netherlands and Finland) and the southern bloc.

Until now, Germany has largely succeeded in dictating the region’s economic and monetary policies.

But the southern bloc – which represents more than half the region’s population – now blames Berlin-backed policies for the withered state of their economies.

Increasingly, these southern countries are demanding policy changes to boost jobs and growth and seeking to water down demands for austerity.